Fiscal Management of Local Administration Forum

Ankara, TurkeyMay 23, 2008

Michael G. Schaeffer

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Good Local Government Public Management Practices:Improve public sector performance supported by

performance monitoring and incentivesSeparate policymaking and service delivery

functionsDecentralize / devolve service responsibilitiesProvide for greater managerial flexibility in

financial managementProvide for greater accountability/transparency in

government operationsEnhance ability to finance more effective service

delivery

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Impetus for Better Local Government Financial Practice ReformsStems from the recognition of:

1. Substantial wealth tied to local government fixed and property assets

2. Potential income or cost savings to be achieved from running municipal services

3. Budget constraints … prompting cost cutting measures, but still retain same or improved services

4. Reforms may increase the ability of municipalities to finance infrastructure and improve service delivery

5. Accelerated approaches to better manage local government assets

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Accounting Reforms Accelerate Improvements in Asset ManagementMove toward accrual accounting (IAS, GAAP) has

made inroads with respect to local governments managing:Financial assets (cash, etc.), and,Real assets (property, roads, etc.) more

appropriatelyChanging accounting methodology from cash to

accrual changes will impact:1.Manner that fixed and other local assets are

accounted 2.Information flows that are needed to comply with

newly adopted accounting standards04/19/23 4

From a Local Government Finance Perspective: Cash AccountingLocal governments traditionally operate via

annual budget requestsAnnual appropriations assigned on the basis of

these requests.Cash accounting eliminated the need for a

balance sheetAll transactions are annual cash transactionsCarry-over provisions existCapital assets are written off in the year

completedValue of assets is not accounted for in public

ledgers04/19/23 5

From a Local Government Finance Perspective: Accrual AccountingFinancial statements should report:

All AssetsAll LiabilitiesAll RevenuesAll Expenses (including interest, principal)Gains and Losses

For capital assets, accrual account shows asset values related to debt

Implies that governments should:Identify and record all assetsAttach a value to each asset (include

depreciation/amortization)Then re-evaluate these assets later (Mark –to –Market)

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Why are Accounting Systems Important?Local governments are increasingly competing

for international financial resourcesLocal governments need to understand both

the equity and liability side of operations May be more appropriate to use equity (land,

lease agreements, etc. ) instead of debtAccrual accounting increases the potency of

local government financial reporting (now includes a balance sheet) Provides more information to creditors, rating

agencies, etc May translate into lower cost of borrowing

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The Balance SheetLocal government’s balance sheet identifies

all of the assets and liabilities that have financial value

Local government balance sheet same accounting equation as in the private sector:

Assets = Liabilities + Equity

In public sector, this can be rearranged:

Citizens/Taxpayer Equity = Assets – Liabilities04/19/23 8

Understanding Local Government Balance Sheets is ImportantAssets / liabilities of local governments are

large compared to annual budget revenues / expenditures.

For financial choices a more useful instrument is the balance sheet.

Local municipal government should consider its appropriate mix of asset ownership in light of its service priorities and its mission.

Possible to consider asset ownership choices within a budgetary framework, but it seems more natural to analyze it as a portfolio (assets, liabilities, etc ) choice.

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Use of Accrual Accounting and the Balance SheetAccrual accounting matches revenue stream to

offset the annual charge associated with amortizing capital cost

For example, if fixed asset is:Amortized over twenty years as an expense,Corresponding revenue stream shown on the other

side of the ledgerRevenue stream may be derived from a capital

charge May either be an imputed charge, or, Actual payment

Introduced as primary means to force users to recognize true cost of using/consuming the asset

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Linking the Balance Sheet, Strategic Asset Management, and Capital Investment PlanningCategorize “Portfolio” of government assets

by useGovernment, Social, Surplus

Essential to specify a different financial (and social) goal for each category

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Asset Portfolio Classification Model

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Asset Use Financial Goal Example of activity or Property

Example of Financial

information needs Government Use Maximize efficiency

and minimize costs Water / Sewerage plants, Hospitals.

Expenses, capital investment costs, internal rent, value-in-use.

Social Quantify and minimize the subsidy

Housing, parks, economic development

Expenses, investment costs, subsidy, market value.

Surplus Maximize financial returns

Land lease, fee parking lots, small land/building parcels

Expenses, revenues, market value.

Justification of Government Use AssetGovernment Use Assets:

Increasing efficient use of facilities - require governmental departments to justify their demand for space, additional facilities (e.g., schools, hospitals etc.)

Justification process should include capital outlays, operations and maintenance, depreciation and amortization calculations

Minimize operating costs  

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Justification of Social Use and Surplus Property AssetsSocial Use Assets: Property used to satisfy social

objectives of the governmentThe financial goal is to quantify and minimize (where

possible) the subsidy The goal for social assets can be achieved by:

Presenting true capital, operational and maintenance, depreciation and amortization expenses to facilitate the best decisions.

Surplus Property : Real assets (properties) not needed for federal use or social programs The goal for these assets is to maximize their financial

return (which requires the highest and best use of the asset, if possible) and to control costs

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Understanding the Balance Sheet: Provides a Broader Possibilities Of Sources and Uses of Funds

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Sources of Funds (Revenue) Uses of Funds (Expenditure) 1. Operating Budget Surplus 1. Infrastructure Investment 2. Capital Revenues 1a. Water & Sewer 2a. Capital Grants from Higher Level 1b. Roads 2b. Betterment Levies 1c. Etc 2c. Impact Fees & Developer Contributions

2d. Asset Sales 2. Other Capital Improvements 3. Borrowing 3. Investments in Economic

Development Activities 4. Capital Contributions from Public-Private Partnerships

4. Capital Contributions to Public-Private Partnerships

Expanding Funding PossibilitiesHistorically, principal sources of funds on the revenue side

of budget include:Operating/current account surplusCapital grants/transfers from higher levels of

governmentBorrowing

Range of possibilities for public financing increased (not just debt):Betterment leviesImpact fees / developer contributionsSale of land assets (Istanbul Metropolitan Municipality

approximately US$1.5 billion)Borrowing backed by land collateral Various combinations of public / private partnerships

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Concluding RemarksAccrual accounting increases potency of local

government financial reporting , includes a balance sheet

Accrual accounting provides more information to creditors, rating agencies and public private partnership investors

Municipal balance sheets may expand the ability of municipalities to finance infrastructure and improve service deliveryMunicipalities should be able to use equity (land,

etc) not only debt to finance infrastructure projectsGreater transparency – may translate into lower

costs of borrowing

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